Knock off Ford Motor Co.’s promised contribution of up to $600 million (Rs2,406 crore) to Jaguar Land Rover’s (JLR) pension plans, and it turns out that the net consideration from the sale is just $1.7 billion. That’s less than one-third its acquisition cost for the two brands, which totalled $5.23 billion. TataMotors Ltd’s investors would be hoping their company fares better.
There’s little reason to believe Tata Motors would be able to revive JLR’s fortunes dramatically. To begin with, there are hardly any synergies with its current operations. In fact, the Tatas have to rely on Ford for some supplies, which may well lead to an increase in the cost structure of these luxury cars. But these details are not known. What’s also not known is whether the acquired business generates enough cash flow to support the heavy research and development and other capital expenditure required to support a luxury car business. (With luxury cars, you have to keep coming up with new models to keep sales growing.) That’s unlikely, going by the way Ford has been writing off its investment in JLR. In both 2005 and 2006, when Ford collectively wrote off $2.9 billion as impairment charges, it had noted that it was because of a decline in net cash flows.
Besides, Tata Motors would have to service the additional large debt raised to fund the acquisition, which will further eat into the cash flow that’s generated. Its existing business is well positioned in terms of cash flow generation, but it has its own large capex plans.
All the company has said as far as JLR’s financials go is that its revenues are in excess of $14 billion and that both brands are profitable. But as pointed out earlier, what matters more is the free cash flow—if it’s negative, Tata Motors would have to continually borrow to make up for the shortfall. As it is, the company has raised a bridge loan of $3 billion to fund the transaction, which is higher than the amount to be paid to Ford ($2.3 billion). Analysts say this may be to fund JLR’s capex in thenear term.
With the Tata Nano to be launched soon and its break-even likely to take a while, the consolidated financials of the company could be under pressure in the near term.It’s hardly a wonder that the spreads on credit default swaps on Tata Motors have widened substantially since mid-January, around the time the company was selected by Ford as the preferred bidder. Tata Motor shares, however, seem oblivious to some of these worries—they have outperformed the Nifty since mid-January. The fact that Ford will bear the pension deficit is a positive, but the larger worry related to JLR’s troubled history and the risk of high leverage remains.
Does Ashok Leyland’s fund-raising spell good times ahead?
Shares of Ashok Leyland Ltd fell by 1% on Wednesday, in line with the drop in the broad market, after it announced it had raised $200 million (Rs802 crore) through external commercial borrowing. Proceeds from external borrowings can be used only for meeting forex requirements of capital expenditure and for other overseas investment purposes. Ashok Leyland has a heavy capital expenditure plan for the next three years, but according to an analyst the large external borrowing indicates that an overseas acquisition may be in the offing. Such a development would have led to a sharp jump in the stock a few months ago, but considering the state the markets are in currently, it’s not entirely surprising that the stock fell in line with the broad market. The stock now trades at just 10 times trailing earnings, down more than 40% from its 52-week high.
Considering that earnings are expected to grow in strong double-digits in the near term, valuations seem reasonable. The company recently benefited from the cut in excise duty on buses by 400 basis points and on commercial vehicles by 200 basis points. Prices of its products have been cut (after being raised marginally a few days prior to the Budget), but this would hardly lead to incremental demand, since interest rates are still high, one of the main reasons offtake has been affected. The cut in excise duty would, to some extent, help the company offset rising material costs.
One concern for large commercial vehicle companies such as Ashok Leyland and Tata Motors Ltd is the increase in competition, with Volvo entering into a joint venture with Eicher Motors Ltd and Daimler Trucks partnering with the Hero group.Besides, existing players are raising capacity. Ashok Leyland and Tata Motorsshould be able to hold on to their share, thanks to a strong distribution network, but the increase in competition could lead to a pressure on margins.
At its peak of about Rs58 a share, Ashok Leyland traded at around 18 times trailing earnings, partly ignoring these risks. While the shares have now corrected, upside would largely depend on the state of the market, unless the company actually announces an acquisition.
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